Topic: Economic Analysis & Policy
Big banks step in with $30 billion to save San Francisco-based First Republic Bank
After SVB failure, Haas faculty raise concerns about systemic weaknesses in banking
As repercussions from the stunning collapse of Silicon Valley Bank (SVB) continue to ripple through the banking industry, we asked Haas experts for their views on where the system broke down and whether there may be broader trouble viewing.
Professors Ross Levine, Panos Patatoukas, and Nancy Wallace said SVB’s problems were “banking 101” and that its management and board failed in their fiduciary duties. Levine, a banking industry expert, said the situation “suggests stunningly incompetent bank supervision and regulation,” and cited research that Silicon Valley Bank may be “the tip of a gigantic iceberg.” Patatoukas agreed, asking “If (regulators) cannot spot something as straightforward as SVB’s issues, then what else are they missing?”
Professor Ross Levine, Willis H. Booth Chair in Banking and Finance, Haas Economic Analysis & Policy Group
“Silicon Valley Bank (SVB) failed in the simplest and most vanilla way. It had long-term assets, including Treasury securities and other U.S. government backed-securities, and short-term liabilities, namely deposits. This exposed the SVB to interest rate risk because long-term securities are much more sensitive to interest rate changes than deposits. As interest rates went up over the last year, the price of long-term securities went down, challenging SVB’s solvency.
Regulators at the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) did not need sophisticated supervisory and regulatory skills or elaborate training to recognize such interest rate risk. It is banking 101.
While new information might emerge, current knowledge suggests stunningly incompetent bank supervision and regulation. The Federal Reserve and FDIC regulators need to explain why they did not require SVB to hedge interest rate risk three years ago, two years ago, etc.
The apparent failure of Federal Reserve and FDIC regulators in the case of SVB raises questions about the effectiveness of U.S. regulatory authorities in general. First, if regulators failed to address the most basic of risks—interest rate risk—in SVB, did they miss this interest rate risk in other banks? Second, have regulators effectively addressed the more complex risks that some banks take? Third, did regulators allow systemic risks to grow in the U.S. banking system?
Recent research provides an alarming answer to whether the Federal Reserve and FDIC blew it on interest rate risk beyond SVB, suggesting that SVB is the tip of a gigantic iceberg. A study conducted over the weekend indicates that the market value of U.S. banking assets is about $2 trillion dollars less than the reported book value due to increases in interest rates during the last year. It is impossible to determine the degree to which banks used derivatives to hedge interest rate risk. Thus, one cannot conclude definitively that the U.S. banking system experienced a loss of $2 trillion. However, these statistics, in conjunction with the details on SVB, scare me.
While Secretary of the Treasury Janet Yellen and Jay Powell, Chair of the Federal Reserve Board, might claim that the U.S. banking system is very well capitalized and very well supervised and regulated, they have some explaining to do.
Recent events also raise concerns about the competency of U.S. monetary policy, which, like much of bank regulation, is conducted by the Federal Reserve. The Federal Reserve started raising interest rates a year ago to combat inflation. (As a side point, the Federal Reserve created the inflation it is now combating.) It should have been evident to the Federal Reserve that banks with long-term assets and short-term liabilities that had not hedged interest rate risk would experience significant losses as interest rates rose. Moreover, the Fed has or can obtain information on banks’ assets and liabilities and the degree to which they were hedging interest rate risk. Thus, they knew—or should have known—which banks were most exposed to interest rate risk as they started raising interest rates. As a result, even if bank regulators failed to force banks to address interest rate risk before the Federal Reserve began to raise rates, the Fed should have been aware of this vulnerability as it started tightening monetary policy to fight inflation.”
Associate Professor Panos Patatoukas, the L.H. Penney Chair in Accounting, Haas Accounting Group
“The SVB management and board failed in their fiduciary duties. The Fed also failed in its supervisory role since it failed to spot a basic duration mismatch and a massive run-prone deposit base, together with a lack of interest rate risk management on the part of SVB. It would have been straightforward to see from SVB’s financial statements that its (tier 1) liquidity ratio was much lower after accounting for the accumulated but unrecognized losses from the revaluation of their long-term bond portfolio, which basically indicates that SVB had elevated risk well before the run on the bank.
The SVB failure raises concerns about structural problems impacting regional banks, their depositors, and capital providers. It also raises concerns about the ability of regulators to spot risks ahead of time. If they cannot spot something as straightforward as SVB’s issues, then what else are they missing?”
Professor Nancy Wallace, Lisle and Roslyn Payne Chair in Real Estate and Capital Markets
“This is a monumental failure of risk management on the part of both the bank and the regulators. Interest rate risk is basic banking 101. Added to that is the very large depositor concentration from one industry. I also suspect that the loans on (Silicon Valley Bank’s) balance sheet are likely to be poorly underwritten given the overly cosy relationship between the bank and the king makers in Silicon Valley. They frequently provided loans to startups as a bridge between funding rounds. They did this to protect startup founders from the dilution effects of additional equity rounds—the more normal way to fund startups.”
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‘If you can be in the room, you can help.’ Berkeley Haas economists share insights on advising world leaders
Influencing national economic policy is not only about having the expertise, but also about being in the room at the right moment to be heard, two top economists who have served as government advisors told the audience a recent Dean’s Speaker Series event.
“I had this impression that there’s some deep thinking and careful preparation, and ultimately a bunch of guys get into a room, and later there’s a law,” said Professor Ulrike Malmendier, who in August was appointed to a five-year term on Germany’s Council of Economic Experts, which evaluates the government’s economic policies. The reality, she learned, is less concrete.
“I completely misunderstood politics and policy,” said Malmendier, Edward J. and Mollie Arnold Professor of Finance, in response to a student question. “It showed how if you are at the right place—if you can be in the room—you can help.”
Malmendier shared the stage by Professor Catherine Wolfram, who recently completed a term as Deputy Assistant Secretary for Climate and Energy Economics in the U.S. Department of Treasury. Wolfram and Malmendier were interviewed by Haas Dean Ann Harrison in a discussion titled, “In the Halls of Power: Berkeley Haas Economists on Advising World Leaders.”
Wolfram, an energy economist, and Malmendier, a behavioral economist, are internationally known in their respective fields. Both said they felt the call to step outside academia and use their expertise in the service of public good.
“Like a lot of my colleagues, I wanted to be relevant to policymakers, and I wanted to have my research influence decisions,” Wolfram said. “But I figured I really should understand what it’s like to be a policy maker and see how the sausage is made.”
Wolfram said that when Janet Yellen, a Berkeley Haas professor emeritus, was named Secretary of the Treasury in the Biden Administration, she reached out to her directly about a treasury position focused on environmental issues
“…Don’t wait for them to come to you. Life in DC is so, so hectic, they’re going a million miles an hour,” Wolfram said. “You need to raise your hand and say, ‘I’m ready. I’d like to be there.’”
“You need to raise your hand and say, ‘I’m ready. I’d like to be there.’” —Catherine Wolfram
Wolfram ended up having a front-row seat to the passage of the Inflation Reduction Act—the biggest climate bill in U.S. history—and played a pivotal role in enacting a price cap on Russian oil. Malmendier has been on the front lines of helping her home country navigate a tricky economic period roiled by inflation, the war in Ukraine, and the resulting European energy crisis.
Hear more about their experiences and their leadership advice.
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Berkeley Haas Dean Ann Harrison on her days as a globetrotting development economist and her new book
(Photo: Copyright Noah Berger / 2018)
As a young economist, Dean Ann Harrison traveled the globe for the World Bank, lugging home reels of magnetic tape from mainframe computers that she gathered from census bureaus in developing countries. She poured over the data she collected, asking questions like: Does freer trade and globalization help or harm workers? Do wealthy multinational corporations help local economies by raising wages, or is it the reverse, and do they exploit cheap labor?
The academic work she produced, as a faculty member at Columbia University, Harvard University, UC Berkeley, and the University of Pennsylvania’s Wharton School, propelled her to become one of the foremost scholars in trade and development economics. She is now the world’s most highly cited scholar on foreign direct investment.
In 2019, Harrison took on a more public role with her appointment as dean of the Haas School, adding a new dimension to a career of serious scholarship that also included serving as director of development policy for the World Bank.
A new book, “Globalization, Firms, and Workers” (World Scientific Books 2022), collects Harrison’s path-breaking work on globalization, trade, and foreign direct investment into a single volume.
We sat down with Dean Harrison to hear more about her work.
Haas News: In the introduction to your new book, editors Keith Maskus and Jed Silver note that your work “shone a light on workers who were not the focus of academic studies in the past, including those in sweatshop industries or multinational firms that were pursuing low-cost labor around the world.” Tell us the backstory of how you came to this work.
Ann Harrison: I was always interested in international issues because I came from an international family. My father was American, my mother was French; I was born in France and French was my first language, and we always went back and forth between France and the U.S. As an undergraduate at Berkeley, I started off as a history major and I became fascinated by questions like: Why are some countries rich and other countries poor? Being a Berkeley undergraduate you naturally gravitate towards these kinds of questions. And then I became interested in the economics of these inequalities, and what we can do about them. By the time I graduated, my goal was to eliminate world poverty. I cold-called the World Bank, since that was their mission, and they told me the most effective thing I could do was to become an economist. So I got my PhD in economics and I started working at the World Bank.
You were working in developing countries at a time when data wasn’t all that accessible. How were you able to gather your data?
In the early- to mid-eighties when I started doing this research, you had to go to Washington and sit in Census Bureau offices to get national data. But as a World Bank staff member, we had more access to emerging market company data. The World Bank lends billions of dollars a year to emerging markets and we would go to countries to help them devise their policies. We supported them in their analysis, and they supported us in our research and data collection. That put me in a position where I was able to get access to census data sets that in the U.S. nobody had access to.
First I went to Caracas and visited their census bureau. I signed documents saying I wouldn’t release their data and they handed me reels of tape from mainframe computers. In some countries, the data sets weren’t so big, so I could get them on floppy disks. Later, they started making PCs, but they were really big and heavy, and I had to get on planes with these heavy computers. I would carry everything back to Washington and the technical people would help me figure out how to read the data. We worked on it for months and even years. I still have some of those tapes— in my basement and I might even have some in the storage closet in the bathroom of the Dean’s Suite.
How many countries did you visit for your research?
I don’t have a tally, but some of the places I went to are Guyana, Trinidad and Tobago, Saint Lucia, Morocco, Pakistan, India, Argentina, Chile, and Jamaica. I spent my 30th birthday in Saint Vincent and the Grenadines—that was nice. I’m sure there are more.
What’s your dinner party answer when people ask you, as a trade economist, has globalization left us better off or worse off?
Economists usually just add up all the winners and subtract out the losers and if the answer is greater than zero, then globalization is good for you. And I think it is true that, on net, it’s been good for a lot of countries. It’s been good for China, which is much richer than it was before. It’s generally been good for the U.S. in terms of access to cheaper goods and more efficient supply chains and opportunities to buy and sell things that we couldn’t have done before. But it hasn’t been good for everyone.
The big mistake economists made is that they underestimated how difficult it would be to compensate those who lost out from increasing global competition. The benefits of globalization hinge on us being able to use the gains to help those who are hurt. But that part of the policy package was not well executed. What could have been good for everybody just ended up benefiting parts of society and hurting others.
The term “globalization” has become a dirty word, synonymous with the loss of the working class, erosion of manufacturing jobs, and rising inequality. Right now we’re seeing a rise of right-wing populist leaders—such as Italy’s Giorgia Meloni—lashing out at globalization, gaining support from workers who feel left behind. How much can we blame the decline of manufacturing and good working-class jobs on globalization?
Technology and automation are replacing people beyond manufacturing—think Amazon fulfillment centers. If you’re educated, you’re doing pretty well, but if you don’t have a college education, you’re doing worse and worse. That inequality is largely being driven by automation. There’s no question that trade did play a role in undermining manufacturing wages. The pain is real. But I found that automation played a much bigger role. We know that’s true because even in China the percentage of workers engaged in manufacturing is declining and people are being replaced by machines. I would say about 75% of the decline is from automation and technology and 25% is from globalization.
You had a counterintuitive finding in one of your papers about Mexico. The assumption was that free trade would benefit workers in Mexico, but it was only the most skilled workers who benefitted while low-skilled workers lost out.
Yes, that’s right, because in order to benefit from globalization you need a lot of knowledge, skill and education. What happened is that Mexico’s unskilled workers were undercut by even lower-wage workers elsewhere in the world. It was a race to the very bottom.
It’s a really interesting case because Mexico put a lot of weight on going global. The leaders really believed that globalization was going to make them richer. The jury is still out.
What are some of your other surprising findings?
Here’s one that is surprising—at least to proponents of globalization. When multinational firms went into a country like Venezuela, the multinationals took away significant market share of the local companies. It may sound obvious, but a lot of governments still welcome investment by foreign firms because they think it will make them better off. What some of my research showed is that this market-stealing effect could be really big and it could hurt you.
The Chinese government figured this out a long time ago. They decided to only let in foreign firms if they partnered with domestic companies. And then eventually policy makers phased out all the benefits that they accorded to the foreign firms. Today foreign companies get no benefits at all in China. So while China understood this from the beginning, a lot of other countries, including the U.S., provided all these benefits like tax subsidies to incoming multinational firms. We thought about the benefits of investment but we didn’t think about the costs in terms of the foregone market share for domestic firms.
You also studied sweatshops.
I did a series of papers on the anti-sweatshop movement. The question was: If you target global companies that set up “sweatshops” and shut them down, what happens to the workers? Are they better off, and is it possible to get to a win-win outcome? What my research showed is that a win-win is possible if you encourage the companies that are already making huge profits to share more of those profits with the workers. But if you force companies that are barely profitable to share more of the meager profits they have, they might go under and workers will lose their jobs.
Another unusual finding looks at what happens when you get rid of special protection for very small firms. In India, 80% of workers work in really small enterprises, and intuitively you would think that removing protection for those firms would not be good for employment, wages, and investment. But it turns out that removing protections was really good for employment and wages because the government had been protecting firms that were so small that they wouldn’t ever get to economically efficient sizes. There wasn’t enough employment growth, wages weren’t high enough, productivity was low. When these laws, called small scale reservation policies, were phased out, wages and employment overall grew.
That was a form of industrial policy, which is another area you’ve studied closely. What is your overall conclusion about industrial policy?
I think there are good kinds of industrial policy and there are bad kinds. You don’t want to promote declining industries. You want to promote the emerging growth areas that are going to create a lot of great jobs tomorrow. What China has shown is that if you systematically promote advanced industries, you can move much more quickly. And so what China has done is given a lot of sectors an artificial advantage. China is not trying to prevent its steel industry from going under. They’re thinking about what are going to be the leading sectors tomorrow and trying to get a leg up there.
You’ve managed a rare career combining serious academic scholarship with public service and leadership. How has your academic work influenced your leadership as dean?
Great question. It has turned out that my three top priorities, innovation, sustainability and inclusion—which I refer to it as my ISI agenda—are the very things I focused on in my research. I don’t think it’s by accident. A lot of the research that I did over the decades was about what happens to people’s livelihoods when they’re exposed to trade and globalization. Who’s helped and who’s hurt? So I’ve always been interested in this question of inclusion and that’s something I’ve brought to my role as dean by prioritizing DEIBJ.
My long fascination with companies is based on questions such as how to identify the companies that are successful, and how to measure innovation at the company level. How do you create something better? So this focus on innovation and the creation of new companies or better ways of doing things is something that I’ve brought to my role as dean.
Right now I am really prioritizing sustainability. When you travel, you see first-hand the huge environmental issues that we’re facing. Access to clean water and access to clean air are fundamental challenges that countries face. Earlier in my career, I became a professor at UC Berkeley’s College of Natural Resources in Agricultural and Resource Economics. And before I became Dean, the last project I worked on looked at how you make environmental policies effective in emerging markets where compliance and enforcement are big challenges. I became interested in green industrial policy, which is industrial policy focused on sustainability and environmental economics. And then when I moved back to California, the first things I noticed were wildfires, drought, blackouts. That just reinforced the importance of sustainable policies. I’ve really taken all that research and background and I’ve used it here as Dean. I’ve gone back to my old contacts at the World Bank and the College of Natural Resources, and we’re partnering with them, and we are building sustainability into our core curriculum so that every Haas graduate can lead in this area.
You’ve talked a little bit about some of the mistakes that were made with globalization, and we’re now in a period of even greater inequality. Do you see any hope of reversing that?
That’s one of the reasons I took this job. I think public education is the solution. That’s the hope. We’re sitting on top of part of the solution right here.
Passing along housing wealth from parents to children
How salary benchmarking by employers affects workers’ pay
A wave of pay transparency laws aimed at reducing inequities is giving millions of workers access for the first time to information on what co-workers make and what potential employers will offer.
Yet comparing salary information is nothing new for employers. While U.S. antitrust law prohibits employers from directly sharing salary information with each other, most mid-sized and large companies routinely use aggregated data from third parties to get a read on the going rates.
The effects of this widespread practice, known as salary benchmarking, have never been systematically studied—until now. Following White House concerns that benchmarking may be used to suppress wages and benefits, a new study offers the first evidence on its impact on workers.
The conclusion: Benchmarking does not have a negative effect on pay for the average employee. While some salaries decrease and others increase after a company uses a benchmarking tool, salaries overall simply move closer to the benchmark.
“If there was a negative effect on salaries, it would be suggestive of anti-competitive effects,” said Associate Professor Ricardo Perez-Truglia, who authored the new National Bureau of Economic Research working paper with Zoe B. Cullen and Shengwu Li of Harvard University. “That’s not what we found. If anything, we see some small salary gains for low-skill occupations.”
The researchers used aggregated data from the nation’s largest payroll processing firm to see how much employers paid new hires in hundreds of job categories before and after they used the payroll firm’s salary benchmarking tool. They found that employers paid new hires much closer to the median wage after searching the market rates for those job titles.
As a result, some new employees earned more and some earned less than they would have otherwise. “For the most part, they sort of cancel each other out,” said Perez-Truglia.
Direct sharing prohibited by law
Although U.S. law prohibits employers from directly sharing information about their employees’ compensation with each other, they can access aggregated salary data from third parties such as management consultants and payroll processors. As part of the study, the authors surveyed human resource professionals who set pay at medium and large companies and found that 87.6% use salary benchmarks, usually from multiple sources.
In July 2021, Biden issued an executive order encouraging the attorney general and Federal Trade Commission to consider revising federal guidance that lets neutral third parties share compensation information with employers—but not employees—without triggering antitrust scrutiny. “This may be used to collaborate to suppress wages and benefits,” the White House said in a fact sheet.
At that time, there was no research on the impact of benchmarking. Perez-Truglia said regulators may be responding to studies and news reports suggesting that industry consolidation is giving employers too much market power when it comes to setting salaries.
The new study, which began in 2019, looked at starting pay offered to new hires at 586 firms that gained access to the benchmarking tool between January 2017 and March 2020. The online tool is easily searchable by job title and is based on real, aggregated and anonymized payroll records of many millions of employees.
The researchers divided the new hires into two groups: nearly 5,300 new hires where the company had searched the benchmarking tool before hiring, and a “control group” of 40,000 hires in the same companies that had not been searched. They compared pay for the two groups in the five quarters before and five quarters after the company first gained access to the salary data.
As a second control group, they looked at salaries offered to about 157,000 people hired during the same time periods in comparable roles at similar companies that never gained access to the more precise salary tool.
‘Compression toward the benchmark’
They found that on average, both high and low salaries moved closer to the benchmark. Among “searched” positions, the absolute difference between the new hire’s starting salary and the median salary for that position dropped from about 20 percentage points before the firm gained access to the tool to about 15 percentage points after. This drop is “large in magnitude, corresponding to a 25% decline,” the authors wrote.
To illustrate this “compression toward the benchmark,” suppose the median pay for a bank teller is $40,000. Without that information, one bank might pay $30,000 and another $50,000. “Once they see the benchmark information, they are much more likely to pay new hires around the $40,000 benchmark,” Perez-Truglia said.
The researchers added that “the effects on salary compression coincide precisely with the timing of access to the benchmark: The compression was stable in the quarters before the firm gained access to the tool, dropped sharply in the quarter after the firm gained access, and remained stable at the lower level afterwards.”
For searched positions, compression around the median wage was much stronger among low-skill positions, which generally don’t require more than a high school degree, than high-skill ones. Dispersion around the benchmark dropped by 40% for low-skill jobs versus 14.6% for high-skill ones.
“This finding is largely consistent with the anecdotal accounts in interviews with compensation managers, according to which low-skill positions are treated as commodities and thus should be paid the market rate,” the authors wrote.
They did a similar analysis looking at average salary levels and found that benchmarking “does not have a negative effect on the average salary. If anything, the effect on the average salary is positive, but small in magnitude and statistically insignificant.”
Specifically, they found the average starting salary for all searched positions was either 0.2% lower or 1.7% higher than the two control groups, respectively.
There were some statistically significant gains for low-skilled employees: Their average pay increased by 5% or 6.7% depending on the control group. The study also found that the small boost in salary for low-skilled employees increased their retention. More precisely, there was an increase of 6.7 percentage points in the probability that those employees were still working at the company one year later.
“This evidence suggests that firms may be using salary benchmarking to raise some salaries in an effort to improve, among other things, the retention of their employees,” the paper says.
For high-skill positions, starting pay went down by 2.9% or 1.6% depending on the control group, “but those effects must be taken with a grain of salt, because they are statistically insignificant,” Perez-Truglia said.
“Typically low-skilled employees are less likely to negotiate than high-skilled employees. They are often made take-it-or-leave-it offers,” Perez-Truglia said. Benchmarking could provide “more equality for those workers.”
There is also a growing body of literature on pay transparency, but much of it focuses on giving employees more access to information, usually as a way to reduce gender and racial pay gaps. A new law in California requires all private employers with 15 or more employees to provide pay ranges in all job postings starting Jan. 1. Colorado, Washington, and New York City have passed similar laws.Although employees can’t access the same kind of “super-sophisticated” pay data that employers can use, Perez-Truglia said, they can use online sources such as Glassdoor, LinkedIn, Teamblind.com and Levels.fyi to get a read on competitive salaries. Companies are also consulting these sites, he added, which generally rely on employees reporting their pay at current or past employers